Navigating Your Licensing Agreement to Success

Everyone has seen a Shark Tankepisode where an offer was dramatically canceled, at the last moment. In almost every case, the inventor became a bit too greedy or unwilling to compromise, causing the shark to rescind an otherwise potentially lucrative deal. What a crushing experience for the inventor!

Something quite similar often occurs when an inventor is negotiating a licensing agreement for his or her invention, with similar results for strikingly similar reasons. The inventor may say, “How could this happen, I thought we had a deal?” Let's look behind to curtains to discover exactly why the deal fell apart and then how to avoid this debacle.

In every licensing deal, the company – or licensee – is preparing to take on considerable risk: spending millions to source, manufacture, package, distribute, and market the inventor's product into thousands of retail stores and other outlets. Rolling out any new product is very risky – remember New Coke? Sometimes consumers simply do not like or accept a new product – no matter how much market research suggested otherwise. Sometimes the failure comes from unforeseen glitches or product liabilities.

The easiest answer for any large company in considering a new product is no. No one ever gets fired for choosing not to go forward with a new product that might fail. But green-lighting a product that later flops gets the key decision-makers responsible fired. Given all of this, it should come as no surprise that the licensee is hoping for a smooth, long-term relationship with the inventor – with no surprises.

The inventor, on the other hand, almost always feels a bit slighted.

“Why should I get a puny 5% royalty, when the company gets to keep 95% of the profits?”

Furthermore, the agreement will typically stipulate the company may withhold a ‘residual' of 10% from royalties to cover customer returns and damaged shipments. Most companies pay royalties only on a quarterly basis. Often, the company may choose to make the product from cheaper materials or eliminate some features to reduce manufacturing costs and increase profit margins.

The result? The inventor asks (or even demands) a better deal. He or she may ask for a higher royalty percent or ask for a significant up front payment or advance against future royalties. Sometimes the inventor will stubbornly rebuff any changes the company proposes to make to the invention.

For the licensee, all of these surprisescause them to rethink the deal.

The inventor has signaled with their actions, loud and clear, that they are going to be difficult to work with. If they are this difficult now, there are probably going to be more surprises and problems in the future.The company quietly, but firmly, rescinds the offer. The licensing deal falls apart.

Wise inventors recognize the licensee is taking considerable risk and that they will almost certainly have a different vision for the product than does the inventor. This means, the company will reduce manufacturing costs using less expensive materials or eliminating some features of the product. The company will probably choose a different name to market the product under.

All of these things happened to me when Allstar Products licensed my thin wallets, I called Savvy Caddy, under their trade name of Wonder Wallet – and I was fine with it. Why?

I understood that I was only risking my patents or IP (even that is not true since they were licensing, not owning the IP). I was giving up all the headaches of manufacturer problems and miscues, damaged and returned goods in exchange for royalty checks that I could spend any way I chose. I had no COGS (or cost of good sold) because I was not selling anything, they were carrying all of that burden. I had manufactured in China for 8 years, I was happy to turn that over to them!

The licensee was taking the risk and, as a result, had the leverage in deal making. In my case, Wonder Wallet has been a huge success, selling over 1 million wallets in the first year – allowing me to pay off debts and take nice vacations to Australia and Peru.

It seems that receiving a tiny royalty percent on a huge sales volume can still be a lucrative deal – even for the inventor.